Thursday, February 10, 2011

The debate over deflation vs. inflation continues, and this chart shows one good reason why: they both have been with us for the past 16 years.

As I first pointed out in a post last May, 1995 marked the point at which—for the first time since the data were collected beginning in 1959—the prices of durable goods (e.g., cars, computers, TVs, equipment) started declining, while nondurable goods (e.g., food, energy, clothes) and services (e.g., plumbers, accountants, banking) kept rising. Since then we have seen the prices of services rise by 55% and nondurables by 40%, while the prices of durable goods have fallen by 25%. So although we are paying more for food, energy, and plumbers these days, we are paying less for the technological prowess and capabilities of those beautiful flat-screen TVs and awesome iPads.

Meanwhile, over the same period, disposable personal income per capita in the U.S. has risen by 84%. This means that an hour's worth of work today buys about two and a half times as much in the way of durable goods as it did 17 years ago. That's an incredible and unprecedented development, and we have the Chinese to thank for much of it. This also underscores how important global trade can be to prosperity: the Chinese have risen out of poverty and U.S. consumers' living standards have improved.

Not coincidentally, 1994 marked the beginning of the modern era for the Chinese economy. The yuan suffered a 33% devaluation against the dollar in early January, 1994, but following that it was pegged to the dollar for 11 years. China's monetary policy was thus effectively outsourced to the Fed, and China's inflation rate fell from almost 30% in early 1994 to zero by 1998 as a result. Thanks to a strengthening currency, low inflation, and market-liberalizing policy moves, China's economy since 1994 has quintupled in size, propelled in part by explosive growth in its exports of cheap manufactured goods. China has supplied us with cheap goods, allowing us to spend more on other things and thus raise our living standards. To be sure, China has bought a lot of our Treasury debt, but that has allowed them to create one of the strongest currencies in the world; a devaluation of the yuan today is almost unthinkable. Strong currencies beget strong economies, and China is allowing the yuan to strengthen further against the dollar. Meanwhile, in exchange for cheap TVs, computers and cellphones, we have supplied China with capital, technology, movies and software, among other things. It's been a match made in heaven.